Question

Consider a commercial space with two tenants. An upscale restaurant and a live music venue. Currently, the restaurant is open serving customers until 10pm each night and the venue has music beginning at 9pm each night.

The live music causes a disturbance at the restaurant harming the restaurant owner's profit, so the owner is demands the music venue does not begin operating until 10pm. The venue owner counters that the restaurant should just close an hour early, at 9pm.  

The following are the hourly profits both firms will earn depending on various closing times.

• Scenario A: Both businesses are open between 9pm and 10pm: The restaurant earns $400 in profit and the venue earns $600 in profit between 9pm and 10pm.
• Scenario B: The venue does not open until 10pm: The restaurant would earn $1200 in profit between 9pm and 10pm, the venue earns no profit since it is closed during that time.
• Scenario C: The restaurant closes at 9pm: The restaurant earns no profits between 9pm and 10pm. The venues profit are not impacted by the restaurant, they still earn $600 profit in this scenario.

Assume no transaction costs.

a) Between the three scenarios, the efficient outcome is Scenario ["A", "B", or "C"] and the most inefficient outcome is Scenario ["A", "B", or "C"]      

b) Suppose the restaurant has the property rights, meaning if the restaurant loses profit due to the venue, the venue must pay the amount of the restaurant's lost profit. After any and all negotiations, does the Coase Theorem predict the venue will open at 9pm or 10pm?

c) Suppose the venue has the property rights, menaing the venue is not responsible for any profit lost by the restaurant. After any and all negotiations, does the Coase Theorem predict the venue will open at 9pm or 10pm?

d) Should, in any scenario, the restaurant pay the venue to stay closed until 10pm, what range of values represent an improvement to both tenants compared to the status quo? ["$200 - $400", "$400 - $600", "$600 - $800", "$800 - $1000", "$1000 - $1200"]      

Answer 1

a)Scenario B is the most efficient one as the total profit is $1200 and outcome C is the most inefficient one as the total profit is $600.

b)If the restaurant has property rights, then it would either not allow the venue to open or ask for the compensation. if the venue opens at 10 pm , he would earn no profit in the hour and if he opens at 9 pm , the profit would be $600. If the venue decides to open and the restaurant has the property rights, then the venue could compensate the restaurant with an amount of $600, which he would have earned had the venue would not have opened.

In other words, it is better if the venue remains closed in the hour, rather than opening and compensating the restaurant.

c) If the venue has property rights, then it would open and earn $600 between the hour. But if the restaurant wants to open, then it would give $600-800 to the venue holder to close. Since the property rights are with venue, it si upto them to decide if they want the compensation or operate. Otherwise also since the property rights are with venue, it can continue to operate and earn $600 because the closing of restaurant has no gain or loss to the venue.

d) If venue is closed till 10 pm, then it would have a loss of $600. Also this would mean that the restaurant is having a profit of $1200 rather than 400. So if the restaurant compensates the veneu anywhere between his profit and the venue's loss, both of them would be well off. This would mean that the range would be between 600 to 800.

800 because the difference between the profit without and with opening of venue is 1200-400=800